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The Role of Collateral Frameworks in the Aftermath of the Financial Crisis

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Swiss Finance Institute
Tuesday, June 20, 2017 - 08:00

Mario Draghi has famously declared that the ECB will do “whatever it takes to preserve the euro.” The ECB’s collateral policy has been central to this, but how did it inject money into the economy?

Before the most recent financial crisis, three major credit rating agencies were allowed to take a position on collateral value. These were S&P, Moody’s, and Fitch. Only the highest rating is considered, irrespective of the other two. And the higher the rating, the lower the haircut. The lower the haircut, the more money can be issued against the collateral. Consider that a fourth credit rating agency—DBRS—was granted entry to this golden circle of agencies in 2009. And that DBRS gave higher ratings to certain types of collateral. For instance, countries like Italy, Portugal, and Spain. This despite the fact that these countries were rated lower by the other three agencies. The collateral ratings by DBRS enabled around EUR 200 billion to EUR 300 billion to flow into the Eurosystem by means of these countries issuing bonds.

In addition, the ECB weakened its eligibility criteria by admitting 10,000 securities on non-regulated markets to the public list of eligible collateral. While there is not enough space here to list the merits and demerits of all 10,000, the effect of the move is clear: it increased the number of eligible securities—most of them were unsecured bank bonds—substantially.

The pros and cons of this move can be hotly debated, but those who suspect a degree of political instrumentality in the process may well be justified.

Written by by Stuart Garforth, finance writer, London and Zurich

This article draws on Prof. Kjell G. Nyborg’s Collateral Frameworks: The Open Secret of Central Banks—the first book-length study of the importance of collateral frameworks in monetary policy and financial markets, focusing on the eurozone and euro crisis.

Read other related posts on this topic:
Never Heard of Collateral Frameworks? You’re not Alone
The Absence of Market Forces at the Heart of the Monetary System

ECB’s Liquidity Injections Distort the Economy
How Central Banks Control More Than You Think